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Sub-prime beast won’t drown in sea of liquidity


WHAT one veteran banker dubbed the ‘securitisation monster’ created by financial innovation has bitten back. And it is proving to be a painful lesson for those who reposed faith in securitisation to make financial risk a thing of the past by spreading it around so thinly that it could no longer be detected.

The question now is, how much more damage will the beast do before it is tamed or put back in its cage?

One man who is not underestimating the dangers is Japan’s recently appointed minister in charge of financial services and administrative reform, Yoshimi Watanabe, who declared yesterday that the fallout from the sub-prime debacle could yet become a ‘tremendous problem’ for Japan.

The securitisation monster (as Shinsei Bank chief investment officer Mark Cutis has dubbed it) took a big bite out of the US sub-prime mortgage lending market. But not content with that, it went on to maul socalled structured investment vehicles and hedge funds, before snapping viciously at the very heart of the US and European banking systems.

Now, it turns out that Asian financial institutions have also been savaged more seriously than at first feared. Reuters published a list this week of Asia-Pacific firms that have revealed actual or potential damage through exposure to structured products such as collateralised debt obligations and asset-backed securities as a result of the fallout from the sub-prime market debacle.

As the Institute of International Finance in Washington has remarked, this could be just the tip of the iceberg. The roll call so far includes Australian hedge fund manager Basis Capital, Macquarie Bank and Rams Home Loan; Taiwan’s Cathay Financial Group; Singapore’s DBS Group and United Overseas Bank; the Bank of China, Industrial and Commercial Bank of China and China Construction Bank; Japan’s Sumitomo Mitsui Financial Group, Mitsubishi UFJ Financial Group, Shinsei Bank as well as Nomura Holdings.

There may be more to come in Japan, as minister Watanabe admitted. His agency will watch very closely the half-term results due soon from Japanese banks and other financial institutions to see how many more problems they reveal. But not all accounting regimes are as (relatively) transparent as Japan’s; and even in Japan (as in other advanced economies), the scope for ‘window dressing’ of accounts is  onsiderable.

Thus, the relative calm that has descended on Asian and other emerging markets may be deceptive, as the Institute of International Finance in Washington said recently. For one thing, asset holders domiciled in emerging market countries may simply not have recognised fully as yet the losses they have suffered on financial instruments linked directly or indirectly to defaulted mortgage-backed obligations in the US and elsewhere. For another, the tangled web of instruments spawned by securitisation is so hard to untangle.

Rating agency Standard & Poor’s also acknowledged this week that ‘global debt markets’ are in the midst of a jarring repricing of risk. ‘Uncertainty abounds, but we believe the financial sector as a whole has sufficient strength to absorb significant bank loan and securities markdowns, reduced earnings in investment banking and trading, and increased credit losses that are sure to come in the second half of 2007.’

The fact is that no one wants to take the blame for the meltdown that occurred in global financial markets last month – and which is still rumbling like an angry volcano beneath a surface that has been temporarily cooled by jets of emergency liquidity from central banks.

It has all been a kind of act of God from which we must learn lessons, was the message of leading central bankers meeting in Jackson Hole, Wyoming, last weekend.

There were suggestions from some of the lesser bankers that the current crisis is the price to be paid for financial innovation – a suggestion also advanced by a prominent analyst at a seminar that I moderated in Tokyo last week, where he argued that the crisis is simply the teething troubles of a ‘new financial architecture’ that was spawned recently.

Such arguments allow regulators to get off the hook too easily. They knew that financial innovation was running ahead of their ability to police sophisticated new markets effectively. The dictum caveat emptor (let the buyer beware) should never be applied in financial markets. That is one area where many buyers (and many market practitioners too) do not really understand what they are getting into.

The crisis is almost certainly not over yet and it demands much more considered and comprehensive response than just drowning it in liquidity or empty official assurances that all will be well.


Source: Business Times 6 Sept 07


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